Estimated Quarterly Income Tax Payments

Introduction
Safe Estimate
Estimated Tax Penalty
Joint Estimated Tax Payments
What Income and Deductions are Included?
Penalty Rate
Exceptions to the penalty
Criminal Penalty

Introduction

Generally, you should make estimated tax payments for the year if you will owe tax of $1,000 or more, after withholding and credits.

Federal income tax is a pay-as-you-go tax. This means the tax must be paid as income is earned or received. Tax is generally withheld from your wages or salary before you get it, and may also be withheld from other types of income such as pensions and unemployment compensation if requested. However, tax is generally not withheld from income such as alimony, interest, dividends, rental income, self-employment income, and capital gains. You may be required to pay estimated tax on these types of income. Estimated tax is the method of paying tax on income not subject to withholding and on other income from which not enough tax is withheld. You do not have to make estimated tax payments if your 2000 tax return will show a refund, or a balance due of less than $1,000.

Safe Estimate

A "Safe Estimate" is a computation of the quarterly vouchers made to meet the parameters enumerated by the IRS to reduce or prevent the charging of interest by the IRS on tax payments that are required to be made during the year.

90% of the tax to be shown on your current tax return, the IRS will not charge the interest.

100% of the tax shown on your prior year tax return, if your 1999 tax return covered all 12 months of the year.

However, if your prior year adjusted gross income exceeded $150,000 (or $75,000 if you filed a separate return from your spouse for the current year), then you must pay 106% instead of 100% of your 1999 tax.

    This added amount for high bracket taxpayers changes from year to year and you must check with your adviser to ascertain the correct %.

Also, the penalty may be waived if:

1. The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty; or
2. You retired (after reaching age 62) or became disabled during the tax year a payment was due or during the preceding tax year, you had reasonable cause for not making the payment, and the underpayment was not due to willful neglect.

Estimated Tax Penalty

You may have to pay a penalty if you do not pay enough tax through withholding or estimated tax payments, or if you fail to make required estimated tax payments by the due dates. Estimated tax payments can be used to pay federal income tax, self-employment tax, and household employment tax.

In addition, if you made estimated tax payments, the payments must usually have been in approximately equal amounts to avoid a penalty.  However, if you made unequal payments because your income was received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income.

Knowing how to annualize the income will help you to make the estimated taxes so that they replicate the annualization method.  The following are the periods used to annualize income on the computation of the penalty:

Generally you will not know the amounts until the time period has elapsed.   Therefore you will want to monitor your income and expenses for those time periods and adjust them accordingly.

Joint Estimated Tax Payments

Where a husband and wife make joint payments of estimated tax but file separate returns, the payments must be allocated between them. (§1.6015(b)-1(b)).   If the husband and wife fail to agree on a division, the estimated tax payments are allocated between them in proportion to the aggregate amount of income tax (including the alternative minimum tax) and self-employment tax shown on their separate returns.   The source of the funds used to make the payment is irrelevant.

What Income and Deductions Are Included?

Your expected adjusted gross income for the current year is your expected total income minus your expected adjustments to income.    This is all of your income which is taxable.

Total income: Include in your total income all the income you expect to receive during the year, even income that is subject to withholding. However, do not include income that is tax exempt.

Total income is all the items of income and loss that for the current year are included in the total on line 22 of Form 1040, line 14 of Form 1040A, or line 4 of Form 1040EZ. When figuring your net earnings from self-employment, be sure to use only 92.35% of your total net profit from self-employment.

Social security and railroad retirement benefits. If you expect to receive social security or railroad retirement benefits during the year, include only the taxable portion.

Underpayment Penalty Rate

The penalty is computed by applying the underpayment rate to the amount of the underpayment.  The underpayment rate is the interest rate (not compounded) charged on tax deficiencies (i.e., three percentage points over the average market yield on outstanding marketable obligations of the federal government with remaining periods to maturity of three years or less), rounded to the nearest full percent and adjusted quarterly. However, the rate does not change for the period between March 31 (the end of the first quarter) following the taxable year and April 15 (the due date of the return for the taxable year (without extension)).

See §6654(a)(1); §6621(a)(2).
See §6621(b).

Exceptions to the penalty

No penalty is imposed for underpayment of estimated tax if the tax shown on the return (or if no return is filed, the tax) for the taxable year, reduced by the credit for income taxes withheld, is less than $500.  For taxable years beginning after December 31, 1997, the de minimis threshold is $1,000.

§6654(e)(1).
§6654(e)(1), as amended by §1202 of the Taxpayer Relief Act of 1997 (P.L. 105-34).

The penalty for underpayment of estimated tax is not imposed for any taxable year if: (1) the preceding taxable year is a 12-month period; (2) the individual does not have any liability for tax for the preceding taxable year; and (3) the individual is a U.S. citizen or resident throughout the entire preceding taxable year.

§6654(e)(2).

In General

There is no general exception to the underpayment of estimated tax penalty for reasonable cause as there is for many other penalties. The IRS, however, is required to waive the underpayment of estimated tax penalty in two situations involving extreme hardship -- (1) where it would be against equity and good conscience to impose the penalty, and (2) when the individual retires or becomes disabled.  These waivers should only be used as a last resort and not as a planning device.

§6654(e)(3).

Against Equity and Good Conscience

No estimated tax penalty is imposed if the IRS determines that the imposition of the penalty would "be against equity and good conscience" because of a casualty, disaster, or other unusual circumstances.  The IRS has typically used this power to grant limited relief to taxpayers affected by changes in the law -- including statutory changes  and required changes in accounting methods as a result of court decisions and natural disasters.  A waiver is also warranted where the taxpayer designates that an overpayment of tax shown on a prior return is to be credited against estimated tax, but the overpayment is offset either for past-due child support or for non-tax federal debt, and the taxpayer is not notified of the offset prior to the due date of the estimated tax installment.

§6654(e)(3)(A).

Retired or Disabled Individuals

The IRS must also waive the penalty in the case of an individual who retired after having attained age 62 or became disabled in either the current taxable year or the immediately preceding taxable year, if the IRS finds that the underpayment is due to reasonable cause and not willful neglect.  In the case of a joint return, the waiver is available if either the husband or the wife satisfies the retirement or disability test. 

6654(e)(3)(B).

January Return

No penalty is imposed with respect to an underpayment of the January 15 installment if the individual files his tax return for the year on or before January 31 and pays the balance of the tax shown on the return.  Farmers and fishermen have until March 1 of the succeeding taxable year to file their returns and pay the tax due.  By filing a return and paying the tax by January 31 (March 1 in the case of a farmer or fisherman), the individual can effectively defer his last estimated tax installment from January 15 to January 31 (March 1 in the case of a farmer or fisherman), without any penalty. It would, however, accelerate the payment of any tax liability in excess of his estimated tax.

§6654(h).
§6654(i).

Bankruptcy Under Title 11

A special exception may apply if the individual is in bankruptcy under Title 11.   No penalty is imposed for an underpayment of estimated tax by a bankrupt individual if the underpayment results from a bankruptcy court order finding a probable insufficiency of funds to pay administrative expenses (including taxes). On the other hand, if the payment is due prior to the commencement of the bankruptcy case, the penalty will not be imposed if the bankruptcy petition was filed before the due date of the tax return for such year or the date for imposing the penalty occurs after the petition is filed.

§6658(a).

Criminal Penalty for Willful Failure to Pay Estimated Tax

In addition to civil penalties, a criminal penalty is imposed upon any person who willfully fails to pay any estimated tax required to be paid.   Upon conviction, a fine not exceeding $25,000 and/or imprisonment for not more than one year may be imposed. In addition, the taxpayer must bear the costs of prosecution.  The criminal penalty, however, may not be imposed unless the civil penalty for underpayment of estimated tax is also imposed.
§7203.
§7203.